Balancing greenwashing risks and forest carbon sequestration benefits: A simulation model linking formal and voluntary carbon markets

Voluntary carbon markets (VCMs) offer energy-intensive firms a cost-effective means to reduce carbon mitigation expenses through promoting forest conservation. However, concerns about greenwashing may deter firms from using these options, which are susceptible to illegal forest harvesting. This study examines whether firms purchasing carbon credits from forestry-based communities can help strengthen forest conservation, mitigate project risks, improve environmental outcomes, and reduce abatement costs. We examine a large Indian steel firm, with an annual production capacity of 4 million tons, issuing green bonds to fund afforestation in Himalayan forest communities. Using industry-level average emissions, abatement costs, and output data for Indian firms, we develop a dynamic optimization model to determine optimal abatement strategies, considering the risk of future forest carbon loss from VCMs. The model, utilizing examples and data from existing carbon sequestration programs in the Himalayan states, offers insights into promoting high-integrity VCMs through formal emission market linkage. Findings suggest that firms' involvement in compliance emissions markets provides an alternative route to accessing affordable carbon credits when abatement costs are high. Additionally, engaging in the VCM reduces expenses related to emission reduction targets. However, with elevated greenwashing risks, firms reduce their use of green bonds in VCMs. Participation in the VCM positively reinforces forest conservation and enhances environmental services when greenwashing risks are absent, further lowering carbon mitigation costs. To enhance VCM integrity, further research is needed on how community conservation norms influence illegal harvesting.